Inventory is only worth what it can produce in sales.
My comments here are very philosophical and general in nature, but because I get so many inquiries on this topic, I thought it might be good to discuss it. Most, if not all, of the principles here apply to most any business, not just recycling businesses.
I have been hired many times to help determine the value of a yard (not including real estate), in cases ranging from contract disputes, tax cases, condemnations, and assisting buyers and sellers. I have never heard of a salvage yard (not including real estate) selling for more than one times annual sales, and most often it sells for much less.
Typically, the sales price for the business is a multiple of earnings (about four times earnings), which need to be legitimately recast to correct errors. Another method is to use the value of the assets. An operation with significant upside can be worth more than four times earnings.
It’s funny, most sellers are “just turning the corner on earnings” and nearly always see significant upside, even though they have been in the used parts business for decades. These numbers are very much estimates, and rely on many factors. For instance, if all your equipment is worn out, expect to get dinged for at least part of that cost taken off of the indicated price as a multiple of earnings.
In asset discussion, the value of used parts inventory always comes up. Typically,
it can’t be worth more than about three months sales (from that inventory, not including brokered parts or car sales).
Many folks think because their warehouse is bursting at the seams, with hundreds of engines, that the inventory is worth a ton. INVENTORY IS ONLY WORTH WHAT IT CAN PRODUCE IN SALES. Maybe it won’t surprise you, most recyclers are pack rats and save way too many parts, that are unlikely to ever sell. Yep, squeeze that last nickel of revenue, but spend a dime to do it pulling and saving parts.
The earnings used for the multiple must include fair market value rent (which will drive the land value), and compensation for the owner.
The land may be worth more for other uses, and if so, sell it for those uses and close the yard. Also, a typical well-run yard shouldn’t need more than 10 acres (many do well with three to seven acres), so I suggest you sell the yard with the land currently being utilized, not to exceed 10 acres, and sell rest of the land to another user who can pay top dollar. No need to buy a shopping center to get a store, from the buyer’s perspective.
The land value for the wrecking yard should be driven by the rent payment being made, using a 8%-10% or so return on investment. A typical real estate investor will want a higher return due to environmental risk. Obviously, an ex-operator could settle for less of a return, as they are more comfortable with the risk. So, your P&L should show the rent, before net earnings. If the rent is say, $3,000/mo., or $36,000 per year, on a triple net lease (where the tenant pays insurance, taxes and most other expenses), the land is worth about $400,000 for the yard use (give or take some, but not much; I’m using a 9% return).
If you aren’t paying yourself enough rent, why not? Why do you care, you keep the profits? If your land is worth more than $400,000, you’re not paying enough rent. Many operators, who think they are making money, aren’t making anything because they aren’t paying themselves enough rent.
If, after rent ($36,000), and adequate compensation to owner (at least $50,000), cost of goods sold and other expenses, you still have earnings, of say, $35,000 (10% of sales), the business is worth a maximum of $140,000 (four times earnings), and the land is worth about $400,000 based on the rent being paid. If the rent isn’t market rate, or there has been significant development in the area, the land could be worth more of course, perhaps much more. Obviously if the earnings are more and can be proven, the business could be worth more.
My experience is that owners hardly pay themselves anything, and rent isn’t being paid, or is not at market rates. Once the rent is adjusted to the right rate and the owner is paid a reasonable amount, the earnings are negative – which means the whole enterprise is worth commensurately less, if anything, and it is likely time to liquidate, sell the land, and retire.
Ninety percent of people that contact me are unrealistic about the value of their business. Their savior is that their land is worth more for other uses. If you are looking to sell your business, be sure to find out what the land is worth – it may be time to close or move the business and realize the value of the land.
I look forward to seeing old friends and making new ones at this year’s ARA Convention in November in Dallas.
Ron Sturgeon, speaker and author, regularly shares his expertise in strategic planning, capitalization, growing market share, and more, providing his field-proven and high-profit best practices. Reach him at 817-834-3625, ext. 232 or email RonS@MrMissionPossible.com. Remember only you can make business great!
